Remaining in government hands will only lead to further corrosion of RBS

James Barty
THIS week has seen a flood of major banking announcements: the Parliamentary Commission on Banking Standards, the chancellor’s Mansion House speech, and the details of the Prudential Regulation Authority’s (PRA) capital raising demands. It was a distinctly mixed bag, with some good, some bad, and some downright ugly.

The good came in the Parliamentary Commission’s recommendation that bankers need to be responsible for the risks they take, the acknowledgement of the adverse effect of the government holding stakes in banks, and George Osborne’s decision to privatise Lloyds. The bad was the Commission’s desire to shift the burden of proof onto bankers (why should their rights be different from everyone else’s?), the recommendation of a good bank/bad bank split, and the chancellor’s related decision to delay the privatisation of RBS.

And the ugly? This came in the form of the PRA’s drive to force the banks to raise yet more capital. All this would achieve is to reduce by £27bn the capital available for banks to lend.

The chancellor could and should have drawn a line under the financial crisis by saying that he was preparing to privatise not just Lloyds, but RBS, too. Given that he appointed the Commission in the first place, it is not unreasonable that he will want to look again at the proposal to split RBS into a good and bad bank.

But it would have been wise to stick to the line that this would have been the right course five years ago, not today. Stephen Hester, with the chancellor’s blessing, has been running the “bad bank” inside RBS for the last five years and has already successfully shed some £280bn of bad assets. Indeed, Hester has argued with some force that the bad assets would be de minimis by the end of the year. All that can be achieved from spending more time examining whether the good and bad bank split is a workable proposition is to delay the time when RBS can be freed from government interference.

Actually, RBS is in a much better position now than most would have predicted at the time of its effective nationalisation. Under Hester’s rule, liquidity has been improved and capital rebuilt. Despite the PRA’s best efforts to blow a hole in RBS’s capital position, the bank will still (just about) meet the new minimum regulatory requirements by the end of 2013. Either there are tens of billions of bad assets still in the RBS balance sheet that are not covered by loss provisions and extra capital, or the PRA has not done its job properly.

All is not lost, however. The RBS management likely have the best view of its balance sheet and commercial position. We should therefore take their word for it when they say they expect to be ready for privatisation in 2014.

Should the enquiry into the bad bank reach the expected conclusion – that it is not worth it and would likely run counter to EU state aid and competition rules – and RBS continues its return to profitability, then Osborne should be prepared to move it onto a privatisation footing. Keeping it in government hands is not a free option. The longer it is in state hands, the more corrosive it is for the bank. If the chancellor can privatise it in that window, he must do so.

He suggested that this would be via an institutional placing with a retail placing to follow. We would suggest he do the two in tandem, with the retail offering to come in the form of a distribution of shares to the public that would enable all taxpayers to participate, not just those who can pay for the shares upfront. We think this could give the government a higher exit price from Lloyds than more traditional methods, while giving taxpayers rather than institutions the bulk of the upside.

Finally, there is an opportunity to put a stop to the ever increasing demands from the Bank of England for more capital. The Bank and PRA even managed to slip in a leverage ratio that will impact those who have been growing their loan books, such as Barclays and Nationwide. Mark Carney arrives in ten days’ time – and not a moment too soon. He should tell the banks that there will be no more moving of goalposts, and that they have until 2019 to complete their capital adjustment.

If these opportunities can be built upon we can look forward to a 2014 where the good substantially outweighs the bad – and the ugly.

James Barty is head of financial policy at Policy Exchange.